Sustaining Asia’s Momentum: Time for Vigilance and Reform

Vigilance and further reforms needed to sustain Asia’s leadership in global growth

The outlook for Asia is one of steady growth. GDP growth is forecast to improve to 5.5 percent in 2014–15, says the IMF in its latest Asia and Pacific Regional Economic Outlook.

Asia’s momentum is set to continue…

While economic developments in Asia remain uneven, the region will continue to be among the global growth leaders.

The main growth drivers are improving external demand, particularly from advanced economies, robust labor markets, and strong credit growth. Despite the rise in long-term interest rates in many economies, financial conditions across Asia have remained relatively accommodative.

In several economies, action taken by policy makers to address vulnerabilities in the aftermath of the “tapering tantrum” in 2013 have also bolstered resilience, say the authors. Indeed, emerging Asian economies have weathered well the latest bouts of volatility in the global financial markets.

But risks lie ahead…

Risks to the outlook have become more balanced. Global growth has strengthened and overall global prospects have improved (especially in advanced economies). But Asia still faces new and old risks (geopolitical uncertainty, exit from unconventional monetary policy in the United States and low inflation in the euro area).

The main external risk remains an unexpected or sharp tightening of global liquidity. Rapid movements in global interest rates could lead to further bouts of capital flow and asset price volatility. Pockets of high corporate leverage in some Asian economies could magnify the effects of higher interest rates and lower growth on balance sheets, and weaken domestic demand.

Asia is also facing various risks emanating from within the region. Growth in China and Japan could also fall below expectations, with negative spillovers for the rest of the region. In China, a gradual slowdown as a result of reforms would be welcome as it would put growth on a more sustainable path. However, a sharp fall in growth—which remains a low risk—would adversely affect those regional trading partners that are most dependent on Chinese final demand.

In Japan, Abenomics could be less effective than envisaged, resulting in lower inflation and weaker growth, with spillovers to economies that have strong trade and foreign direct investment linkages with Japan.

Strong intra-regional trade integration, which is shown to have contributed to greater business cycle synchronization and spillovers over the years, could transmit geopolitically related disruptions along regional supply chains.

Preparing for the risks ahead: monetary and fiscal policies

While Asia is resilient and policy frameworks are generally sound, the recent episodes of global volatility have shown that policy trade-offs can worsen relatively quickly. This puts a premium on continued vigilance and further reform efforts to underpin growth prospects.

Given relatively low inflation across most of the region, countries generally appear to have space to maintain the current supportive stance of monetary policy. But a gradual normalization of monetary conditions would be warranted as economic prospects continue to improve and downside risks recede.

In economies with high inflation, decisive action on monetary policy will likely be needed to ensure that headline inflation stays on a downward path. The IMF’s REO also notes that, in many of Asia’s frontier and developing economies, curbing rapid domestic credit growth is needed to address domestic and external imbalances.

On the fiscal front, gradual consolidation remains appropriate for most economies in Asia, says the REO. Reforms to raise tax revenues and change the composition of spending so as to prioritize infrastructure and social spending will help rebuild fiscal space and promote more inclusive growth.

Macroprudential tools should remain in the toolkit

The report shows that macroprudential policies have been used more extensively in Asia than in other regions. Some of these measures, particularly those related to restraining housing market excesses, have helped lower credit growth and slow house price inflation.

Macroprudential tools should remain part of the toolkit. But they should be used as a complement to sound macroeconomic and flexible exchange rate policies.

Effective implementation of structural reforms will be critical

The report’s authors note that while adjustments to the macroeconomic policy mix are important, pushing ahead with structural reforms will also be critical to reduce vulnerabilities and sustain the growth momentum.

The reform agenda varies considerably across economies in the region, but in all cases vigorous implementation will be important. The reforms range from those in the recently unveiled blueprint to put growth on a more sustainable path in China, to further labor and product market reforms in Japan. Finally, removing structural impediments to growth and improving the business climate are a priority in most emerging, frontier and developing economies in the region.

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